Inflation and the possibility of a recession are putting economists in the limelight as investors make decisions about where to invest. But Robert Lind, a Capital Group economist based in London, says economists' opinions aren’t always helpful.

“I think economists should show some humility when they make forecasts, particularly when we start talking about inflation and recessions, given that our record in forecasting either of those two things over the course of the last couple of decades hasn’t been great,” he said today at Capital Group’s midyear outlook report.

He was joined by two Capital Group colleagues: Diana Wagner, equities portfolio manager in New York, and Pramod Atluri, fixed income portfolio manager in Los Angeles.

At Capital Group, Lind said, economists, analysts and portfolio managers think in terms of a variety of scenarios that include “known unknowns” so they can attempt to deal with the complex and large-scale shocks that are affecting the global economy. These are the same known unknowns that the central banks are considering, he said.

“One of the biggest challenges for central banks at the moment is simply the scale of the inflation overshoot that we’ve seen, particularly in the U.S. and increasingly in Europe,” he said. “That is challenging central banks because it’s something that none of them predicted. They are only partially understanding why inflation has overshot as much as it has, and they are also cognizant of the fact that policy has been left too loose for too long.”

In addition, there is increasing risk around energy prices, particularly in Europe, given the disruption to energy supply to Europe’s largest economy, Germany. Put it all together, he said, and it’s generating much weaker economic growth than anyone expected six to nine months ago.

Lind said he expected the Fed and the ECB will focus on the inflation part of the equation, but they can’t ignore the softening growth numbers.

“Given the scale of the shocks that we’ve seen, and they are massive, we shouldn’t rule out the fact that policy makers will make mistakes. Over the last 20 years, it’s been relatively easy to run macro policy. This time around, given the scale of it, it’s a much harder environment in which to run the economy, much harder for policy response,” he said. “It increases the likelihood that we will see much greater turbulence and volatility in the underlying macroeconomy, but also importantly in assets prices, which will be very important for financial markets.”

So where do Capital Group’s portfolio managers see opportunity?

Atluri said he sees inflation as the biggest risk, as inflation and volatility are tightly linked right now, and the next few inflation readings will be crucial to anticipating just how aggressive the Fed will be.

“As we look around, the economy is already starting to respond to tighter financial conditions, but no one really knows how far demand has to fall in order to bring inflation back down to comfortable levels,” Atluri said. “To my own view, I think inflation is likely to remain higher for longer than many think.”

For his investments, he said he’s cautious about adding too much risk until he’s confident inflation is actually coming down.

“It’s incredibly difficult to focus on any given sector when everything is just moving around so quickly,” he said.

So his team has taken the position of “gradual contrarians.” As the market began pricing in a more aggressive Fed and the economy showed signs of slowing a few weeks ago, he said, he began adding in duration to get close to a neutral position.

“We’re now a little bit overweight on the front end of the belly of the curve and a little bit underweight the back end of the curve, as we’re starting to see that tighter financial conditions and slowing growth is impacting the Fed’s hawkishness,” he said. “We continue to like TIPS here, but mostly just in the front end, to take advantage of our view that inflation will remain high and sticky for a little bit longer.”

He said he is cautious on long-duration TIPS because those are more dominated by changes in inflation expectations, which could happen a lot as the economy heads toward recession. Yet over the next few months he suggested investors should start looking at bonds to protect against equity volatility and to produce income.

For Wagner, who said she invests based on fundamental, bottom-up research, right now there are some promising investments to be made in businesses that have pricing power and where earnings cuts are less likely.

Included in that group are insurance companies, insurance brokers and health insurance companies, which can benefit from higher interest rates on their short-duration investment portfolios, she said.

She added she also loves beverage companies. “Unlike in foods, in beverages there really isn’t a store brand to trade down to, so these companies have more pricing power,” she said.

Similarly, she likes fast-food restaurants, where the company can pass inflation through the franchises and to which consumers flock when feeling pinched. In addition, these are companies that pay attractive dividends that have continued to grow at a healthy rate, she said.

“Proven dividend growers can definitely help bolster returns when inflation is rising. In fact, nearly half of a market’s return comes from dividends,” she said. “So for me, companies with pricing power and growing dividends are very attractive in this market environment.”

Other long-term opportunities can be found in companies with strong innovation programs, she said, such as healthcare companies, where innovation is taking place both on the product side and the services side, but also where there are attractive valuations on real earnings and cash flow.

And in ESG, HVAC companies that are addressing the fact that 40% of greenhouse gasses are caused by buildings, and 40% of buildings’ energy use is deployed in heating and cooling, make good investments, she said. So do railroads, where “iron on iron is a lot more efficient than rubber on road. So a railroad can move one ton of freight 500 miles on just one gallon of fuel.”

As the global economy’s likelihood of recession rises, making plans for the future includes predicting where it will hit and how hard. One thing’s for sure, Lind said, and that’s where the U.S. goes, so goes everyone else.  

“I think it’s fair to say that if we do get a U.S. recession, it will be very difficult for other economies around the world to decouple themselves away from that,” he said. “The U.S. tends to dictate the global financial cycle. So if the U.S. goes down, it’s going to drag the major European economies with it.”